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How Self Directed IRAs Work: Everything You Need to Know

There are a plethora of paths to choose from when it comes to investing in your retirement. Each path is as diverse as your situations and financial goals and should be tailored to you. IRAs — or individual retirement accounts — are a popular form of retirement account and can be as diverse as the investors using them. A self-directed IRA, for example, is distinct from other types of IRAs because of the kinds of assets you can own in the account. For common investments such as stocks and bonds, a regular IRA account functions well. 

Self-Directed IRAs: Rules and Limitations

As of 2019, your total self-directed IRA contributions cannot be more than $6,000. This rule, however, does not apply if you are 50-years-old or older and are allowed to contribute up to $7,000.1 According to the IRS, this limit does not apply to rollover contributions or qualified reservist repayments.1 A rollover happens when funds from a specific retirement account (ex. an IRA) are distributed and deposited into the same - or a different - account.

Typically, when you roll over a distribution to your retirement account, you will not have to pay taxes on it until you withdraw the funds.2 When this occurs, your money is able to grow on a tax-deferred basis. However, if the money is not rolled over, it will likely not be taxable unless you qualify for any exceptions.2 An exception would be if a qualified reservist, currently inactive in the military, was recalled to active duty. In this situation, the person could be eligible to withdraw from their self-directed IRA early without having to pay a penalty fee. 

Advantages of Self-Directed IRAs

If you prefer having more options, a self-directed IRA might be a better fit for you. With a self-directed IRA, you can choose to invest in a variety of companies, properties, and operations. Perhaps, you are passionate about a specific field or industry, with a self-directed IRA you have the opportunity to put your knowledge to the test. Instead of investing in things you know nothing about, you are able to pursue investments you have a vested interest in, which often makes the experience much more enjoyable. It’s important to note that regardless of the type of IRA you have, you will need to have a person or company hold the account for you.

Regarding a self-directed IRA’s tax advantages, your contributions could either be fully or partially tax-deductible, depending on a variety of factors.3 Oftentimes, both the earnings and gains in your IRA are not taxed until they are distributed.3 Sometimes, this money may not be taxed at all.3 However, if your spouse has a retirement plan at work and your income level exceeds a certain amount, your total tax deduction may be reduced.1

Disadvantages of Self-Directed IRAs

If you are interested in a self-directed IRA, it’s important to consider the amount of responsibility required. By nature of the investment, your custodian will be passive — they will simply hold the account without providing investment advice — you will need to educate yourself on investment best practices if you want to generate consistent, positive returns. Additionally, you will be in charge of managing paperwork and transactions, which will require ongoing dedication. 

In some ways, a self-directed IRA is a part-time job, so you will want to think carefully about your own capabilities and time before making the commitment. For some people, a self-directed IRA may be appealing because, in a way, it forces you to be current with the times. If you don’t, you risk losing a considerable amount of money. A self-directed IRA might be a good fit for people who enjoy the challenge of investing, and who are eager to learn and grow as the market fluctuates. If this doesn’t sound like you, a traditional or Roth IRA may be a more suitable option.

https://www.irs.gov/retirement-plans/retirement-plans-faqs-regarding-iras-contributions

https://www.irs.gov/retirement-plans/plan-participant-employee/rollovers-of-retirement-plan-and-ira-distributions

https://www.irs.gov/publications/p590a

This content is developed from sources believed to be providing accurate information, and provided by Twenty Over Ten. It may not be used for the purpose of avoiding any federal tax penalties. Please consult legal or tax professionals for specific information regarding your individual situation. The opinions expressed and material provided are for general information, and should not be considered a solicitation for the purchase or sale of any security.